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Swiss tax system needs reform says OECD

Economics Minister Johann Schneider-Ammann (l) and OECD Secretary General Angel Gurria (r) on January 24

(Reuters)

Switzerland should radically reform its tax system to boost economic growth, according to the Organisation for Economic Co-operation and Development.

The OECD’s latest economic survey for Switzerland criticised what it said were “unusually high” personal income taxes and “generous provisions” which allow for interest payments on household debt to be tax deductible.

“The Swiss tax system is heavily geared towards the taxation of household income which is more harmful to economic activity than taxation of consumption,” the report said.

“By giving incentives to household indebtedness, the Swiss tax regime can potentially aggravate any future period of financial instability.”

But any major changes to the Swiss tax system are likely to meet strong resistance at home, particularly from the cantons which fiercely defend their ability to set individual tax regimes.

Asked by reporters if he agreed with the OECD’s assessment of the Swiss tax system, Economics Minister Johann Schneider-Ammann said:

“It’s a recommendation. We did not – and we do not – negotiate. That’s not the idea.  Principally I agree. From a general point of view it would be better to shift. But it’s not that easy to find the support in the political world.”

The survey was formally presented to the Swiss government on Tuesday, when Schneider-Ammann accepted the 100-page document from OECD General Secretary Angel Gurria in Bern.

While noting that Switzerland’s economic recovery had been broadly balanced despite the franc's strong appreciation, the OECD warned of a period of stagnation, particularly in manufacturing, in the near term.

“I’m glad to see that this assessment of the general Swiss economic situation is in line with our own analysis,” said Schneider-Ammann told reporters.

A question of VAT

The OECD suggested a number of measures to rebalance Switzerland’s tax system, in particular increasing consumption taxes in favour of reducing personal tax rates. 

Exempting some goods and services from VAT created “significant distortions” of activity, the OECD report said as it recommended widening the base of the VAT and increasing it from the current eight per cent would be growth-enhancing.

“The base of the VAT should be widened, especially by removing exemptions. An increase in the standard VAT rate to financial services should be explored in order to equalise the tax treatment of this sector with respect to other sectors,” the report said.

The OECD said VAT reform should be accompanied by measures to cushion low-income households from real income loses. It said early withdrawals of pension fund assets “should be taxed in full” and the practice of offering lump-sum tax rates for non-economically active people to move to Switzerland should abolished.

Schneider-Ammann noted that the government was engaged in a process of reviewing the issue of taxation.

Strong franc

While noting that the strong franc was a threat to the export sector, the OECD said weakening competitiveness on prices was “more than compensated for” by strong international demand for Swiss goods and services, particularly from emerging East Asian countries.

Hedging its bets, the OECD said slowing activity of trading partners such as Germany contributed to its prediction of a stagnating manufacturing sector but noted:

“Nonetheless, potential growth has not diminished as a result of the crisis, and amounts to about two per cent. It has been supported by a continued large inflow of foreign workers.”

Monetary policy should remain expansionary and fiscal policy should remain prudent, the OECD said. It praised measures taken by the Swiss National Bank to combat the effects of the strong franc – notably the introduction of a floor of 1.20 francs to the euro – as “appropriate to fulfil its mandate to maintain price stability”.

“It is also reassuring that the OECD is supportive of the economic and monetary policy decisions that have been taken in recent years,” Schneider-Ammann told reporters.

Banks and carbon

The OECD said planned reforms to banking regulations should be speeded up to limit the risk to the economy and taxpayers, particularly from “the Big-2” banks, namely Credit Suisse and UBS.

It said that both banks remained highly leveraged and recommended a stricter leverage ratio requirement above the foreseen level of five per cent.

“The low capacity of the ‘Big-2’ to absorb losses requires prompt corrective action, especially in the context of on-going financial instability,” the OECD report said, while noting the two banks held only low exposure to the euro area crisis.

The report also said Switzerland would need to introduce more cost-effective policies if it hoped to meet its greenhouse gas emission reduction targets. It suggested introducing a carbon price on transport fuel could address the CO2 emissions from road transport, which is the sector with the most potential to reduce emissions.

In addition, the report suggested revising rental laws to encourage energy-saving investment in property, and linking the Swiss emissions trading scheme to the that of the European Union.

The OECD

The Organisation for Economic Co-operation and Development was established in 1961. Headquartered in Paris, France, it has 34 member countries and an annual budget of €342 million.

Its aim is to promote policies that will improve the economic and social well-being of people around the world. To do so, it works with governments to understand what drives economic, social and environmental change. It measures productivity and global trade and investment, analysing and comparing data to predict trends and promote policy changes in issues as broad as agriculture, tax and chemical safety.

An Economic Survey is published every 1½-2 years for each OECD country. It identifies the main economic challenges faced by the country and analyses policy options to meet them. 

Source: OECD

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Housing Bubble?

The OECD economic survey of Switzerland 2011 warned the country could face the unpleasant prospect of a housing bubble as Swiss residents take advantage of historically low interest rates to become homeowners.

Interest rates hovered at around zero per cent for much of 2011, with the current target range for the Libor at 0-0.25 per cent.

The OECD said low interest rates have boosted domestic mortgage lending which has been growing vigorously for several years.

“House prices appear to have accelerated and strong mortgage lending is increasing financial risks for banks and indebted households if interest rates were to rise sharply,” the OECD said.

While house prices exceed base valuations in only some areas, the OECD warned that “continued price increases could signal a housing bubble”.

“Indeed, both outstandingly low interest rates and robust income growth generate a propitious setting for asset price bubbles to develop,” the OECD warned.

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